REUTERS/Indonesia's reformers under attack, worry investors

JAKARTA (Reuters) - Indonesia's improving political and economic outlook was a big draw for investors this year, but a fight between reformers and cronies may prove to be a tipping point in sentiment for the region's biggest economy.

At stake is whether Finance Minister Sri Mulyani Indrawati and Vice President Boediono, two technocrats considered among the architects of reform in President Susilo Bambang Yudhoyono's cabinet, are elbowed out by old-school political rivals.

For now that prospect seems unlikely. Indrawati and Boediono have vigorously defended their role in last year's 6.7 trillion rupiah ($709 million) bailout of a small lender, Bank Century.

But the fact they may be questioned by a parliamentary committee next month about the deal means investors are paying closer attention to the case because of the political risk, particularly since it pits Indrawati against long-time rival Aburizal Bakrie, a powerful politician and tycoon.

"If Sri Mulyani was forced out, I think a lot of people would be worried. She represents the high ground, change, and anybody with aspirations of a cleaner Indonesia," said Nick Cashmore, head of CLSA in Indonesia.

The departure of Indrawati, a former IMF official with an international profile and a pro-foreign investment agenda, would reduce prospects for a much-needed overhaul of the civil service, police, and judiciary, as well as the fight against corruption.

It would also remove a firm advocate of sound economic and investment policies, potentially hitting short-term capital flows into the domestic financial markets and long-term commitment to infrastructure, manufacturing and natural resources projects.

Behind much of this year's enthusiasm for Indonesian assets, whether stocks, bonds, the currency or through direct investment in key sectors of the economy, is the realisation that the country may at last be able to achieve its full potential.

Its abundant natural resources -- gas, coal, tin, copper, palm oil -- are in hot demand, while its population of about 240 million people make it an increasingly appealing consumer market for companies ranging from PT Unilever Indonesia, which sells soaps and shampoo, to PT Astra International, which sells cars and motorbikes.

The re-election of President Yudhoyono this year spurred hopes of improving economic growth, seen topping 4.3 percent this year, and has helped drive the rupiah up 16 percent against the dollar, and stocks up 85 percent, while bond yields have contracted.

"INDONESIAN LOVE AFFAIR"

What has had investors and economists talking about this G20 emerging economy in a far more favourable light, one capable of winning an investment grade credit rating within two to three years and a place alongside the BRIC economies Brazil, Russia, India and China, is its push for political and economic reform.

"There's almost a love affair" with Indonesia right now, said Robert Prior-Wandesforde, senior Asian economist at HSBC in Singapore.

"The Bank Century case is a worry. It may be the minor thing that leads everybody to wake up to the fact Indonesia is not going to deliver the kind of reform they want. The risk is there's a slow burn: a point comes that leads the market to wake up and question their previous enthusiasm."

This shift in perceptions comes only a few weeks after senior central bankers suggested Bank Indonesia was considering controls on hot money inflows, prompting a sudden sell-off in the rupiah.

Yudhoyono won a second, five-year term in July thanks to his continued commitment to tackling endemic corruption and spurring economic growth. Much of the success on this front has been thanks to Indrawati and the Corruption Eradication Commission.

Both have taken on powerful, corrupt officials, making many enemies in the process. Now, it seems, it's payback time.

The anti-graft agency (KPK), one of the key weapons in fighting endemic graft, came under attack from the police and attorney-general's office, both of which regularly rank among Indonesia's most corrupt institutions.

Instead of acting swiftly to intervene in support of two senior KPK officials who were apparently framed by police and state prosecutors, sparking a massive public outcry, Yudhoyono insisted the appropriate legal procedures had to be followed.

The president eventually spoke out about the need for legal reform and the two wronged KPK officials were released and returned to their jobs.

But many ordinary Indonesians who have grown tired and frustrated with the level of corruption in the legal system were disappointed by the president's dithering.

More recently, finance minister Indrawati has been criticised over her role in the bailout of Bank Century last year, and is likely to be questioned by a parliamentary committee stacked with politicians who oppose her push for reform.

Both Indrawati and Boediono, who was central bank governor at the time, have said the bailout was necessary to maintain investor confidence in its financial system during the global credit crunch, at a time when financial institutions in several other countries were rescued.

Local media have reported that businessmen who benefited from the bank bailout may have been donated to Yudhoyono's political campaign. Indrawati, Boediono and Yudhoyono have all denied any wrongdoing and urged a full investigation to prove that.

"The level of anxiety is a bit higher than a month ago," over the Bank Century inquiry, said Tim Condon, economist at ING in Singapore.